Wells Fargo Earnings – Behind The Headlines

By Chad Henage - July 19, 2012 | Tickers: BBT, JPM, WFC | 0 Comments

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With recent reports out from both Wells Fargo (NYSE: WFC), and JPMorgan (NYSE: JPM), investors get a chance to see how the overall economy is doing. The tale of the 2 banks is very interesting, as JPMorgan is much more focused on credit cards and mortgage lending than one would think. Wells Fargo on the other hand, while recently getting press about its mortgage division, did not show as impressive numbers when it comes to mortgage originations. Let's take a look at Wells Fargo's most recent earnings report, and see what the bank is doing well, and where they can improve. 

Headline Numbers

With revenue down 1.39%, it's interesting that the company's earnings per share increased 17%. Wells Fargo assisted its EPS growth, by repurchasing just over 53 million shares of common stock in the quarter. With average loans up just 2.25%, and average deposits up 9.05%, I was a little surprised that these numbers were not stronger. With JPMorgan reporting earnings at about the same time, and showing deposit growth of about 8%, you can see depositors are not exactly running away from large banks. BB&T Corporation (NYSE: BBT) has not yet reported quarterly results, but last quarter the company's total deposits grew nearly 15%. This is in stark contrast to some articles I've read, saying that consumers are abandoning bigger banks. With this as a backdrop, let's look at Wells Fargo's individual divisions and see what else is going on.

Community Banking

With Wells Fargo taking over Wachovia, you would expect the company should improve on that beleaguered banks previous operations. You can see this in the community banking results, as total revenue grew 3.86%, and net income grew almost 20%. In addition, and all-important number for every bank is cross sell ratio. Wells Fargo set a new milestone with cross sell averaging 6.0, as a former banker I can tell you it's difficult to reach an average of 3 to 4, much less 6 products per household. So what about the business side of the house?

Wholesale Banking

Wholesale banking showed impressive growth, with 11% year-over-year average loan growth, and 15% average asset growth. While these were certainly impressive numbers, unfortunately they did not translate into higher net income. In fact, net income was down 2%, and a big part of the reason is the bank set aside $188 million for credit losses, versus a $97 million credit to this line item last year. Speaking of lending.......

Consumer Lending

This is the part of the earnings report, that honestly surprised me the most. With all the recent press about Wells Fargo increasing its mortgage lending, you would expect originations to be up significantly. However that was not the case, as home mortgage originations increased just 1.55%. However, applications rose 10.64%, and the application pipeline was up over 29%, which may bode well for future results. While future results for Wells Fargo may improve, JPMorgan is producing today. In the companies recent earnings report, JPMorgan said that mortgage banking originations were up 29%. With these 2 institutions fighting for a large portion of the mortgage market, it's interesting that Wells Fargo lost out on originations to JPMorgan by such a significant amount. Another divergence between the 2 companies is how they treat credit cards.

Credit Cards

An interesting note relative to JPMorgan which has a significant credit card portfolio is that Wells Fargo barely mentioned credit cards in this report at all. The main point the company made was that the percentage of consumers with a Wells Fargo credit card rose from 29.9% to 31% this year. Compare this to JPMorgan, which made sure to tout its credit card sales volume up 12%, and 1.6 million new credit card accounts. You can see that JPMorgan makes credit cards a priority, while Wells Fargo treats them as a cross sell opportunity. Since lending means nothing without credit quality, next month look at the credit quality of the Wells Fargo portfolio.

Nonperforming Assets

The company's nonperforming assets have improved dramatically in the last year, similar to the rest of the industry. Specifically, total consumer nonperforming assets totaled 3.24%. Total commercial nonperforming assets totaled 1.96%. The weighting of consumer lending versus commercial lending is obvious, when you consider that the overall nonperforming asset percentage was 3.21%. Given this is almost identical to the retail percentage, you can see that Wells Fargo is much more of a retail lending institution. Last but not least, let's take a look at Wells Fargo's balance sheet.

Balance Sheet

To be honest, Wells Fargo has some work to do, if they expect to have quality earnings going forward. Just as an example, total loans increased just 1% versus 6 months ago, and total deposits increased a similar 1%. Part of this could be that the company is attempting to liquidate previous Wachovia lending assets. In fact, the total of these previously made loans is over $100 billion. On a positive note, this liquidation portfolio was over $106 billion 6 months ago. Since Wells Fargo is trying to eliminate such a large portion of this old portfolio, this helps explain why total loan growth has been so slow. However, with significant incoming deposits in just the last quarter, I can't help but think that total deposits would have been down if the current quarter had not been so strong. One big positive for Wells Fargo shareholders, has been the company's ability to keep a stable net interest margin. The company's net interest margin was 3.91%, and over the last 5 quarters has remained relatively stable. By contrast JPMorgan's net interest margin is just 2.36%. Though BB&T is a slightly smaller bank, the company actually has a more competitive interest rate margin at 3.75%.

Conclusion

While Wells Fargo has done impressive work in areas such as cross sell and working through the old Wachovia portfolio, the company has some work to do to create strong earnings growth. In my eyes, investors have a choice between Wells Fargo, JPMorgan, and BB&T as 3 top-tier banks. The primary difference between the three, is while BB&T is slightly smaller, the company actually has stronger organic growth than the other two. With JPMorgan yielding about 3.3%, income hungry investors might gravitate towards this name. I personally own JPMorgan, and that was part of the reason I chose the stock. However, with a similar dividend yield to Wells Fargo, analysts expect BB&T to grow earnings by 12.8%, versus 7% growth at Wells. Given that the 2 companies sell for almost the same P/E ratio, it certainly seems that BB&T would be the better investment choice at the current time.

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